Understanding The Market Reaction to Hurricane Harvey

Over the weekend, Hurricane Harvey hit the Texas Gulf coast and is still pounding Houston with unprecedented rainfall. The storm is causing major flooding, and has so far taken the lives of five people. That and the disruption, even devastation, of the lives of many more is, and should be, the focus of most people, but there will also be much discussion of the overall economic impact of the storm.

That is unquantifiable at this point, but initial estimates of the damage are in the tens of billions of dollars. It will have surprised many investors, therefore, to have woken up this morning to find stocks trading slightly higher and oil at a lower price than Friday’s close.

Neither of those things seem to make sense. Houston’s economy is the fourth largest among American cities and in the top twenty-five in the world; the Gulf Coast area that bore the brunt of the storm is peppered with major oil refineries. At first glance, shutting down a multi-billion-dollar economy and about fifteen percent of the country’s refining capacity should force stocks lower and oil higher, but neither of those markets is moving in the expected direction this morning.

The reasons why are slightly different in each case, but there is one common thread: Traders knew the storm was coming and had already priced in most of the potential effects.

Anybody who has ever traded knows how that works. In terms of the short-term reaction, what might happen is usually far more impactful than what did happen. In an earnings report, for example, a change to guidance for the rest of the year often has a bigger impact than how things went last quarter, pushing a stock lower after what looks like a good quarter or higher following a miss of expectations.

Trading and investing are all about speculation. The trick is to forecast where the price of a stock, commodity, whatever is going in the future. What happened yesterday may inform that view, but doesn’t directly affect pricing today.

The S&P’s wobbles last week can be attributed to many things, but anticipation of the effects of Harvey undoubtedly played a part. In effect, anyone who wanted to sell on the overall effect on the U.S. economy has already done so, and as devastating as the storm has been in many ways, the total damage looks to be within the expected range. The market has moved on, and unless estimates of the damage continue to increase, the focus of traders will be elsewhere this week.

The fact that oil is moving lower this morning is even more puzzling to a lot of people. Most are aware that it is a huge part of that region’s economy, and commodity futures markets are notoriously volatile and sensitive to news. The same forward discounting mechanism of markets is at play here but there is another, much simpler reason that oil has not reacted as you might have thought.

From a pricing perspective, oil and the products derived from it, such as gasoline and diesel, are different things. Reducing refining capacity reduces the supply of gasoline and has pushed those prices up, but does not affect oil production. The processed product will be scarcer and therefore more expensive, but if anything, the inability of some refineries to process crude reduces demand for the raw material itself brings the current oversupply in the U.S. more sharply into focus. It is no wonder then that crude oil futures are trading significantly lower this morning.

It is usually true that if the market is doing something that seems crazy to you, it is you that has missed something. Prices reflect the collective wisdom of thousands of specialized experts, and while that is not always infallible, it does, by definition, reflect the dominant view of events. In this case, as catastrophic as Harvey has been to this point, the effect is within the expected range. That may change this week as rain continues to fall, but in that context and for now, lower oil and steady stocks make perfect sense.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.